The Bank of England has done everything possible under the constraints of monetary orthodoxy to cushion the Brexit shock. It is now up to the British government to save the economy, and the sooner the better.
Monetary policy is close to the limits. The Bank’s pre-emptive £170bn stimulus package is brave – and unquestionably the right thing to do in these dramatic circumstances – but it is not an economic bazooka and much of the boost will leak into asset price inflation.
Governor Mark Carney said the package should be enough to eke out a “little growth” and avert a recession in the second half of the year.
Catastrophist talk of an instant downward spiral following a No vote in the referendum – mostly emanating from George Osborne’s coterie – was always premised on the willfully-false assumption that the Bank of England would sit idly by and let it happen. Today’s actions have at least demolished that canard. As Mr Carney said, the imperative now is to make Brexit a “success”.
Such a scenario is not in the gift of the Bank. Only fiscal policy can address a structural economic shock. A soft-landing depends on Chancellor Phillip Hammond delivering on his pledge to “take any necessary steps to support the economy and promote confidence”. Let us hope he is not bluffing.
Mr Hammond said the Government will set out its fiscal plans at the Autumn Statement in the “normal way”, once the Office for Budget Responsibility has made its forecast. While it would be an error to overreact, this timetable is a little nonchalant.
“We need the stimulus right now. This situation is analogous to the crisis in 2008,” said former rate-setter Danny Blanchflower.
He wants an immediate 2.5 percentage point cut in VAT rates to 17.5pc to shore up consumer confidence and spending. “You can do it overnight as a temporary palliative and take it off again in three months if you don’t need it. You could even do ‘cash for clunkers’ again. The risk of doing too much is far lower than the risk of doing too little,” he said.
Mr Blanchflower said the new global consensus in a world of zero rates is that monetary and fiscal policy must act in concert, each reinforcing the other for maximum effect. This is the exact opposite of post-war orthodoxies, but the cult of central bank independence was always a fair weather illusion. We are all Keynesians now.
Ideally, the Government should dust off “shovel-ready” infrastructure projects that already have planning permission, that are needed, that pay for themselves over time, and can be activated quickly enough to serve as counter-cyclical stimulus through the downturn.
These can be funded by Gilts, now trading at record-low yields of 0.68pc for ten years, or by ‘project bonds’ to conserve a degree of free-market discipline. The shovels are literally ready at the Hinkley Point nuclear plant in Somerset, though that perhaps is an infelicitous example.
“There are a number fiscal measures that can be done,“ said James Sproule, chief economist at the Institute of Directors.
“We favour a rise in the annual investment allowance to £500,000 or even £1 million, and the bit of infrastructure we like most is Broadband, which needs constant improvement. The Autumn Statement should be brought forward to early November, and trailed strongly before that,” he said.
The Treasury’s “National Infrastructure Delivery Plan 2016-2021” says the country needs to spend half a trillion pounds on 600 projects, including flood defences, railway electrification, renewable energy, smart power, research on advanced materials, beamless light, and semiconductor catapults, as well as roads, super sewers, and social housing for 160,000 families.
Most of these are not “shovel-ready”, though a few should be by now given that the International Monetary Fund recommended short-term targeted infrastructure spending to counter spill-overs from the eurozone crisis in 2013. If none are ready, then Treasury heads should roll.
My own view is that there should be fiscal package worth 2pc of GDP to carry the economy through the next three years. This should focus on using state funds to leverage public-private ventures, replacing the lost global investment that will inevitably happen during the Brexit transition phase.
The Bank of England has fired the starting shot of a massive policy pivot as Britain disentangles itself from the EU system after 43 years. The quarter point rate cut today and a further £10bn of Gilt purchases each month for the next six months will help to shore up confidence, and may ‘bend down’ the yield curve a fraction more.
Yet borrowing costs are not the problem. The UK has been stuck in an investment slump ever since the Lehman crisis, even though it has never been cheaper to borrow in the known history of the human race. British companies are sitting on £500bn of idle cash already because they cannot see how to make a profit amid secular stagnation.
The Bank’s £100bn Term Funding Scheme is pure monetary creation – though only ‘base money’, a blunt instrument – and it removes the penal rate on loans to banks. This protects the profit margins of lenders against the side-effects of cheap money and keeps credit flowing. It all helps.
The silver lining in Britain’s predicament is that Brexit is – for now – a specific UK shock. Growth is accelerating in the rest of the world. This cushions the blow. Sterling’s 15pc fall in trade-weighted terms over the last year will act as a bigger shot-in-the-arm than the devaluation in 2008-2009, when the global economy was on the rocks.
All the elements of stimulus are coming together: a super-cheap exchange rate, super-easy money, and soon fiscal largesse. With a little wit and national creativity we may yet confound the pessimists.